THE CONCEPT OF GROSS INCOME (DEFINITION)

COMMISSION OF INTERNAL REVENUE vs. FILINVEST DEVELOPMENT

CORPORATION
G.R. No. 163653, July 19, 2011. PEREZ, J.:
FACTS:
Filinvest Development Corporation (FDC) is a holding company which owns
80% of the outstanding shares of respondent Filinvest Alabang, Inc. (FAI), as well as
the 67.42% of the outstanding shares of Filinvest Land, Inc. (FLI).
Sometime in November 1996, FDC and FAI entered into a Deed of Exchange
with FLI whereby the former both transferred in favor of the latter parcels of land
appraised at P4,306,777,000.00. In exchange for said parcels which were intended
to facilitate development of medium-rise residential and commercial buildings,
463,094,301 shares of stock of FLI were issued to FDC and FAI.
On January 13, 1997, FLI requested a ruling from the Bureau of Internal
Revenue (BIR) to the effect that no gain or loss should be recognized in the
aforesaid transfer of real properties. Acting on the request, the BIR issued such
request, finding that the exchange is among those contemplated under Section 34
(c) (2) of the old National Internal Revenue Code (NIRC) which provides that no gain
or loss shall be recognized if property is transferred to a corporation by a person in
exchange for a stock in such corporation of which as a result of such exchange said
person, alone or together with others, not exceeding four (4) persons, gains control
of said corporation."
With the BIRs reiteration of the foregoing request for clarification filed by
FLI, the latter, together with FDC and FAI, complied with all the requirements
imposed in the ruling.
On various dates during the years 1996 and 1997, in the meantime, FDC also
extended advances in favor of its affiliates, namely, FAI, FLI, Davao Sugar Central
Corporation (DSCC) and Filinvest Capital, Inc. (FCI). Duly evidenced by instructional
letters as well as cash and journal vouchers, said cash advances amounted
to P2,557,213,942.60 in 1996 and P3,360,889,677.48 in 1997.
On November 15, 1996, FDC also entered into a Shareholders Agreement
with Reco Herrera PTE Ltd. (RHPL) for the formation of a Singapore-based joint
venture company called Filinvest Asia Corporation (FAC), tasked to develop and
manage FDCs 50% ownership of its PBCom Office Tower Project (the Project). With
their equity participation in FAC respectively pegged at 60% and 40% in the
Shareholders Agreement, FDC subscribed to P500.7 million worth of shares in said
joint venture company to RHPLs subscription worth P433.8 million. Having paid its
subscription by executing a Deed of Assignment transferring to FAC a portion of its

rights and interest in the Project worth P500.7 million, FDC eventually reported a net
loss of P190,695,061.00 in its Annual Income Tax Return for the taxable year 1996.
On January 3, 2000, FDC received from the BIR a Formal Notice of Demand to
pay deficiency income and documentary stamp taxes, plus interests and
compromise penalties, covered by the following Assessment Notices:
(a) Assessment Notice for deficiency income taxes in the sum of P150,074,066.27
for 1996;
(b) Assessment Notice for deficiency documentary stamp taxes in the sum
of P10,425,487.06 for 1996;
(c) Assessment Notice for deficiency income taxes in the sum of P5,716,927.03 for
1997;
(d) Assessment Notice for deficiency documentary stamp taxes in the sum
of P5,796,699.40 for 1997.
The foregoing deficiency taxes were assessed on the taxable gain supposedly
realized by FDC from the Deed of Exchange it executed with FAI and FLI, on the
dilution resulting from the Shareholders Agreement FDC executed with RHPL as well
as the arms-length interest rate and documentary stamp taxes imposable on the
advances FDC extended to its affiliates.
On January 3, 2000, FAI similarly received from the BIR a Formal Letter of
Demand for deficiency income taxes in the sum of P1,477,494,638.23 for the year
1997. Said deficiency tax was also assessed on the taxable gain purportedly
realized by FAI from the Deed of Exchange it executed with FDC and FLI.
Because of this, both FDC and FAI filed their respective requests for
reconsideration/protest, on the ground that the deficiency income and documentary
stamp taxes assessed by the BIR were bereft of factual and legal basis. However,
the Commissioner of Internal Revenue (CIR) failed to resolve their request for
reconsideration/protest within the aforesaid period. With that, FDC and FAI filed on
17 October 2000 a petition for review with the Court of Tax Appeals (CTA). The said
court finds the instant petition partly meritorious. FDC is was ordered to pay the
amount of P5,691,972.03 as deficiency income tax for taxable year 1997. In
addition, petitioner is also ordered to pay 20% delinquency interest computed from
February 16, 2000.
Displeased with decision of CTA, FDC filed a petition for review before the
CA. Calling attention to the fact that the cash advances it extended to its affiliates
were interest-free in the absence of the express stipulation on interest required
under Article 1956 of the Civil Code, FDC questioned the imposition of an arm'slength interest rate thereon on the ground, among others, that the CIR's authority
under Section 43 of the NIRC: (a) does not include the power to impute imaginary

interest on said transactions; (b) is directed only against controlled taxpayers and
not against mother or holding corporations; and, (c) can only be invoked in cases of
understatement of taxable net income or evident tax evasion. The CA upheld
contentions of FDC. With that, CIR filed a petition for review on certiorari assailing
the CAs decision.
ISSUE: What is GROSS INCOME?
HELD:
Pursuant to Section 28 of the National Internal Revenue Code of 1993, GROSS
INCOME is understood to mean all income from whatever source derived including,
but not limited to the following items: compensation for services, including fees,
commissions, and similar items; gross income derived from business; gains derived
from dealings in property; interest; rents; royalties; dividends; annuities; prizes and
winnings; pensions; and partners distributive share of the gross income of general
professional partnership.
While it has been held that the phrase "from whatever source derived"
indicates a legislative policy to include all income not expressly exempted within the
class of taxable income under our laws, the term "income" has been variously
interpreted to mean "cash received or its equivalent", "the amount of
money coming to a person within a specific time" or "something distinct from
principal or capital."
Otherwise stated, there must be proof of the actual or, at the very least,
probable receipt or realization by the controlled taxpayer of the item of gross
income sought to be distributed, apportioned or allocated by the CIR.
Despite the seemingly broad power of the CIR to distribute, apportion and
allocate gross income under (now) Section 50 of the Tax Code, the same does not
include the power to impute theoretical interests even with regard to controlled
taxpayers transactions. This is true even if the CIR is able to prove that interest
expense (on its own loans) was in fact claimed by the lending entity. The term in the
definition of gross income that even those income from whatever source derived
is covered still requires that there must be actual or at least probable receipt
or realization of the item of gross income sought to be apportioned,
distributed, or allocated. Finally, the rule under the Civil Code that no interest
shall be due unless expressly stipulated in writing was also applied in this case.
The Court also ruled that the instructional letters, cash and journal vouchers
qualify as loan agreements and are subject to Documentary Stamp Taxes.